Plunging Rents Will Drag House Prices Down With Them

Plunging rents are great news for renters, but they're lousy news
for homeowners. Aaron Task and I discussed this issue on
TechTicker this morning:

The vacancy rate for rental apartments in the U.S. is now 7.8%
and climbing,
says the Wall Street Journal. This is the highest
vacancy rate in 23 years.

Worse, the vacancy rate is expected to keep climbing through the
winter, ultimately hitting the highest rate on record.

This is good news for renters and bad news for landlords.
It's also bad news for anyone who owns and would like to sell a
house.

Why are rising rental vacancies bad news for homeowners?

Because rising vacancies put pressure on rents, as landlords have
to cut prices to woo a smaller pool of tenants. As rents
drop, meanwhile, one of the key measures of house-price
value--the price-to-rent ratio--also changes, and not for the
good.

All else being equal, when rents drop, the "Housing P/E ratio" --
price to rent -- increases as rents decrease. This is the
same thing that would happen to the P/E ratio of a stock if the
company's earnings began to shrink.

The more the rent/earnings shrink, the more expensive the house
or company is as a multiple of the rent/earnings.

Will people suddenly refuse to pay as much for houses because the
price-to-rent ratio rises a bit? No. But they may
decide to rent instead of buy, which will remove some demand from
the housing market. And, this, in turn, will put pressure
on house prices.

The chart below
from Calculated Risk illustrates the price-to-rent ratio over
the past 15 years. As you can see, it got way out of whack
during the peak bubble years and has now fallen back within the
realm of normal. As rents fall, however, the ratio will
start rising again.

That is, unless house prices fall, too, which is the more likely
scenario.